Since I can’t post 5000 characters in a LinkedIn comment ?, here are my thoughts regarding Anthony Back’s Medium article “There’s No Such Thing As An STO“. I’ll wait here while you go read that. ⏳
Revenue Share not Equity
While there is definitely a lot of hype around STOs, there is a lot that is incorrect or overstated here. The article starts by saying that “when conducting an STO, a company issues equity tokens…that represent the ownership of equity…”. While ETOs will happen, and there are platforms dedicated to them, the vast majority of interest in tokenized securities is around revenue shares. (Of the 500+ projects looking at an STO that I have spoken with, only 3 of them want to issue an equity…)
The whole point of tokenized securities being used as a fundraising tool for SMEs (small to medium sized businesses) as well as business models around real estate, intellectual property (patents, films, music, art) and fungible commodities is that they provide a mechanism for raising capital without equity dilution…for the most part, only startups are considering equities.
Primary Markets Before Secondary Markets. Liquidity Will Come.
If you are investing into a revenue share, you of course want liquidity so as to eventually exit your position, but these are mid to long-term investments, not short-term day-trade or flipping mechanisms like we saw with ICOs. Let’s deal with issuance first and work towards stable, regulatory-compliant secondary markets. Liquidity will come as the regulators catch up (they’re working hard to), and it doesn’t need to be a lot, but if you are investing into a revenue share just to flip it 3 to 6 months later, you don’t know what you are doing. Think value-based stock market investing vs. day-trading.
Regarding secondary markets, they are on their way, but it’s true that this is a stickier problem than the primary markets. In my discussions with regulators across the EU, in the US and in Southeast Asia, this will come, but they are being careful and thorough in defining those frameworks. That doesn’t stop the fact that investing in those projects now in a revenue share is attractive and financially interesting, for both project and investor, regardless of a lack of immediate liquidity.
Community Driven Investor Demand
In terms of investor availability and demand, it’s important to understand that most tokenized securities will focus on either localized or thematic investments: an SME in Lyon, an apartment building in Berlin, a patent portfolio in VR, a Spanish film producer, Mona Lisa tokens, Harry Potter franchise tokens… Much like rewards-based crowdfunding on Indiegogo or Kickstarter, the successful projects bring their community with them. These kinds of projects mentioned before already know their investor pool or can tap their economic community. We don’t expect most of these projects to attract global interest, but that’s not necessary. It could be if you are raising $50m; it’s not when you are raising $2-10m. (And JK, if you want to offer a Harry Potter token, give me a call…)
Regarding jurisdictions, regulators are tasked with protecting investors in their respective country. Issuing a security offering in another jurisdiction, especially through a subsidiary/SPV, puts you under that jurisdiction’s regulations, and requires you to notify your own. Regulators are less interested (much less interested, in general) in the qualified nature of those investors than ones from their own jurisdiction. This will become even more clear as we see more offerings, but most regulators do not currently impose themselves on security offerings that take place abroad…their mandate is local investor protection.
Retail Investor Access
In Lithuania, an EU member state, security token offerings can include up to €5 million per year per project from retail investors. This is validated by the regulator, the Lithuanian Central Bank, and endorsed on the Finance Ministry’s website; we’ve already done it. Regulatory friction free across Europe; completely accessible to projects outside of Europe by notifying your regulator that you are issuing a securities offering in another jurisdiction. This obviously excludes US retail investors, but it’s a pretty big world out there, and again, we are talking about localized business models for many many of the revenue share STOs. Access for local retail investors to security token offerings is already possible and compliant in the EU and elsewhere.
It is true that there is cost to issuing a securities offering. It costs in the small millions to do a basic IPO in the US plus high annual reporting costs. The point of automating this through tokenization and smart contracts and applying a validated legal framework with the regulator means that you can cut those costs significantly. While it depends on the business model and jurisdiction, this could cost you $50-100k through the Desico framework in Lithuania. Those options will become even more accessible as the process streamlines with regulators.
It’s Already Started
So let’s repeat our tokenized securities mantra :
- It’s not just about startups
- It’s not just about the US and the SEC (or at all)
If you want to frame this for the US regulatory environment, it’s true that it is more complex, but amazing projects like Republic, CoinList, Securitize and TokenSoft are each figuring out their own approach to solving those complexities. Again, it’s a big world out there, and much of the tokenized securities opportunity will not be about US-based projects or investors, and regulators are already paving/have created a pathway forward.
** this is obviously not financial or legal advice and there are surely details or nuances that need to be worked through given the jurisdiction and business activity of your project. Call your lawyer…or me, I know the right ones. **